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CONFORMED 1.
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UNITED STATES SECURITIES AND EXCHANGE
COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
AND EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number 1-7436
HSBC USA INC.
(Exact name of registrant as specified in its charter)
Maryland
(State of Incorporation)
13-2764867
(IRS Employer Identification No.)
452 Fifth Avenue, New York, New York 10018
(Address of principal executive offices)
(212) 525-3735
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
At October 31, 2003, all voting stock (704 shares of Common Stock, $5 par value)
was owned by HSBC North America Inc., an indirect wholly owned subsidiary of
HSBC Holdings plc.
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2.
HSBC USA INC.
FORM 10-Q
TABLE OF CONTENTS
Part I - FINANCIAL INFORMATION
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Page
----
Item 1 - Consolidated Financial Statements
Balance Sheet 3
Statement of Income 4
Statement of Changes in Shareholders' Equity 5
Statement of Cash Flows 6
Notes to Financial Statements 7
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations (MD&A)
Performance Overview 11
Average Balances and Interest Rates 13, 14
Net Interest Income 15
Other Operating Income 16
Operating Expenses 22
Income Taxes 23
Credit Quality 24
Business Segments 25
Derivative Instruments and Hedging Activities 31
Liquidity Management 33
Off-Balance Sheet Arrangements 35
Capital 39
Market Risk 39
Trading Activities 41
Recently Issued Accounting Standards 43
Item 3 - Quantitative and Qualitative Disclosures
About Market Risk 43
Item 4 - Controls and Procedures 43
Part II - OTHER INFORMATION
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Item 1 - Legal Proceedings 45
Item 5 - Other Information 45
Item 6 - Exhibits and Reports on Form 8-K 45
Signature 46
3.
HSBC USA Inc.
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CONSOLIDATED BALANCE SHEET
September 30, December 31,
2003 2002
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in thousands
Assets
Cash and due from banks $ 2,351,394 $ 2,081,279
Interest bearing deposits with banks 1,426,427 1,048,294
Federal funds sold and securities purchased under resale agreements 4,627,723 2,742,943
Trading assets 11,675,902 13,408,215
Securities available for sale 14,852,003 14,694,115
Securities held to maturity (fair value $4,586,633 and $4,905,162) 4,401,316 4,628,482
Loans 44,907,730 43,635,872
Less - allowance for credit losses 435,127 493,125
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Loans, net 44,472,603 43,142,747
Premises and equipment 678,185 726,457
Accrued interest receivable 299,114 328,595
Equity investments 280,592 278,270
Goodwill 2,815,774 2,829,074
Other assets 4,836,606 3,517,730
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Total assets $92,717,639 $89,426,201
=======================================================================================================
Liabilities
Deposits in domestic offices
Noninterest bearing $ 6,138,635 $ 5,731,442
Interest bearing 36,685,778 34,902,431
Deposits in foreign offices
Noninterest bearing 417,850 397,743
Interest bearing 18,855,901 18,798,723
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Total deposits 62,098,164 59,830,339
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Trading account liabilities 8,077,796 7,710,010
Short-term borrowings 6,466,032 7,392,368
Interest, taxes and other liabilities 4,598,870 3,422,047
Subordinated long-term debt and perpetual capital notes 2,103,210 2,109,163
Guaranteed mandatorily redeemable securities 1,035,564 1,050,942
Other long-term debt 601,528 514,739
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Total liabilities 84,981,164 82,029,608
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Shareholders' equity
Preferred stock 500,000 500,000
Common shareholder's equity
Common stock 4 4
Capital surplus 6,021,897 6,056,307
Retained earnings 1,030,831 578,083
Accumulated other comprehensive income 183,743 262,199
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Total common shareholder's equity 7,236,475 6,896,593
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Total shareholders' equity 7,736,475 7,396,593
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Total liabilities and shareholders' equity $92,717,639 $89,426,201
=======================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
4.
HSBC USA Inc.
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CONSOLIDATED STATEMENT OF INCOME
Quarter ended September 30, Nine months ended September 30,
2003 2002 2003 2002
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in thousands
Interest income
Loans $ 573,652 $ 631,161 $ 1,769,370 $1,896,893
Securities 216,673 226,920 668,910 709,731
Trading assets 29,895 44,224 104,400 118,770
Short-term investments 17,905 34,832 60,827 122,140
Other 3,928 4,957 17,549 16,582
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Total interest income 842,053 942,094 2,621,056 2,864,116
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Interest expense
Deposits 150,450 235,913 511,126 764,984
Short-term borrowings 12,830 58,467 71,329 177,300
Long-term debt 49,604 52,627 155,278 170,729
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Total interest expense 212,884 347,007 737,733 1,113,013
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Net interest income 629,169 595,087 1,883,323 1,751,103
Provision for credit losses (1,305) 39,000 86,195 168,750
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Net interest income, after provision for credit losses 630,474 556,087 1,797,128 1,582,353
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Other operating income
Trust income 23,577 23,561 69,973 71,058
Service charges 54,228 53,860 157,295 152,801
Other fees and commissions 109,546 102,495 333,903 291,305
Other income 36,934 30,547 128,735 78,872
Mortgage banking revenue (expense) (73,628) 12,443 (80,224) 20,895
Trading revenues 51,658 9,799 212,355 56,852
Security gains, net 2,186 16,132 51,219 120,338
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Total other operating income 204,501 248,837 873,256 792,121
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834,975 804,924 2,670,384 2,374,474
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Operating expenses
Salaries and employee benefits 289,697 254,201 846,270 750,165
Occupancy expense, net 39,635 40,184 114,841 114,056
Other expenses 193,382 162,961 539,011 514,396
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Total operating expenses 522,714 457,346 1,500,122 1,378,617
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Income before taxes and minority interest 312,261 347,578 1,170,262 995,857
Applicable income tax expense 114,100 130,628 445,200 368,886
Minority interest in net income of subsidiary (169) -- (516) --
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Net income $ 197,992 $ 216,950 $ 724,546 $ 626,971
============================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
5.
HSBC USA Inc.
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CONSOLIDATED STATEMENT OF CHANGES
IN SHAREHOLDERS' EQUITY
Nine months ended September 30,
2003 2002
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in thousands
Preferred stock
Balance, January 1, $ 500,000 $ 500,000
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Balance, September 30, 500,000 500,000
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Common stock
Balance, January 1, 4 4
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Balance, September 30, 4 4
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Capital surplus
Balance, January 1, 6,056,307 6,034,598
Capital contribution from parent 9,495 11,491
Return of capital (43,905) --
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Balance, September 30, 6,021,897 6,046,089
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Retained earnings
Balance, January 1, 578,083 415,821
Net income 724,546 626,971
Cash dividends declared:
Preferred stock (16,798) (17,398)
Common stock (255,000) (445,000)
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Balance, September 30, 1,030,831 580,394
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Accumulated other comprehensive income
Balance, January 1, 262,199 98,607
Net change in unrealized gains (losses) on securities (127,628) 61,915
Net change in unrealized gains on derivatives classified as cash flow hedges 25,221 57,788
Foreign currency translation adjustment 23,951 (1,913)
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Other comprehensive income (loss), net of tax (78,456) 117,790
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Balance, September 30, 183,743 216,397
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Total shareholders' equity, September 30, $ 7,736,475 $ 7,342,884
=====================================================================================================================
Comprehensive income
Net income $ 724,546 $ 626,971
Other comprehensive income (loss) (78,456) 117,790
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Comprehensive income $ 646,090 $ 744,761
=====================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
6.
HSBC USA Inc.
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CONSOLIDATED STATEMENT OF CASH FLOWS
Nine months ended September 30,
2003 2002
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in thousands
Cash flows from operating activities
Net income $ 724,546 $ 626,971
Adjustments to reconcile net income to net cash provided
(used) by operating activities
Depreciation, amortization and deferred taxes 321,371 479,957
Provision for credit losses 86,195 168,750
Net change in other accrual accounts 582,361 (832,688)
Net change in loans originated for sale (314,600) (1,247,928)
Net change in trading assets and liabilities 969,770 208,420
Other, net (268,188) (216,194)
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Net cash provided (used) by operating activities 2,101,455 (812,712)
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Cash flows from investing activities
Net change in interest bearing deposits with banks (479,389) 2,799,140
Net change in short-term investments (1,794,034) (4,606,865)
Purchases of securities held to maturity (1,924,096) (818,517)
Proceeds from maturities of securities held to maturity 2,366,375 1,014,962
Purchases of securities available for sale (11,870,832) (10,497,502)
Proceeds from sales of securities available for sale 3,460,819 6,512,916
Proceeds from maturities of securities available for sale 8,826,956 3,301,123
Net change in credit card receivables (48,383) 30,620
Net change in other short-term loans (58,102) (402,271)
Net originations and maturities of long-term loans (1,318,903) 90,107
Sales of loans 243,029 189,023
Expenditures for premises and equipment (25,870) (57,959)
Other, net (287,560) 384,941
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Net cash used by investing activities (2,909,990) (2,060,282)
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Cash flows from financing activities
Net change in deposits 2,547,780 (320,996)
Net change in short-term borrowings (1,285,799) 3,674,875
Issuance of long-term debt 125,819 671,959
Repayment of long-term debt (37,221) (512,616)
Dividends paid (271,929) (462,192)
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Net cash provided by financing activities 1,078,650 3,051,030
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Net change in cash and due from banks 270,115 178,036
Cash and due from banks at beginning of period 2,081,279 2,102,756
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Cash and due from banks at end of period $ 2,351,394 $ 2,280,792
=====================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
Pending settlement receivables/payables related to securities and trading assets
and liabilities are treated as non cash items for cash flows reporting.
7.
Notes to Consolidated Financial Statements
1. Basis of Presentation
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The accounting and reporting policies of HSBC USA Inc. (the Company) and its
subsidiaries including its principal subsidiary, HSBC Bank USA (the Bank),
conform to accounting principles generally accepted in the United States of
America (GAAP) and to predominant practice within the banking industry. Such
policies are consistent with those applied in the presentation of the Company's
2002 annual financial statements. In the first nine months of 2003, certain 2003
and 2002 promulgations of the Financial Accounting Standards Board (FASB) and
its Emerging Issues Task Force (EITF) became effective for the Company. Their
adoption had no material effect on the Company's financial statements.
The preparation of financial statements requires the use of estimates and
assumptions that affect reported amounts and disclosures. Actual results could
differ from those estimates. Interim results should not be considered indicative
of results in future periods.
The interim financial information in this report has not been audited. In the
opinion of the Company's management, all adjustments, which are normal and
recurring, necessary for a fair presentation of financial position, results of
operations and cash flows for the interim periods have been made. The interim
financial information should be read in conjunction with the Company's 2002
Annual Report on Form 10-K. Certain reclassifications have been made to prior
period amounts to conform to the current period presentations.
Interim financial statement disclosures required by GAAP regarding segments and
off-balance sheet arrangements are included in the Management's Discussion and
Analysis of Financial Condition and Results of Operations (MD&A) section of this
Form 10-Q.
During the fourth quarter of 2002, the Company adopted Statement of Financial
Accounting Standards No. 147, Acquisitions of Certain Financial Institutions
(SFAS 147). As a result of adopting SFAS 147, $65 million of intangible assets
that were previously reported as identifiable intangible assets were
reclassified retroactively to January 1, 2002 to goodwill and are no longer
amortized. The amortization previously recorded during the first three quarters
of 2002 was also reversed retroactively in accordance with SFAS 147. The net
effect of this reversal was not material to the results of the Company.
2. Goodwill and Intangible Assets
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During the second quarter of 2003, the Company completed its annual impairment
test of goodwill and determined that the fair value of each of the reporting
units exceeded its carrying value. As a result, no impairment loss was required
to be recognized.
8.
The following table presents all intangible assets of the Company that are being
amortized. Total mortgage servicing rights (MSRs) amortization, including
impairment related charges for the year ended December 31, 2003 is expected to
be approximately $220 million. Given current market conditions relative to
interest rates and prepayments, normally scheduled annual MSRs amortization for
the years ended December 31, 2004 through 2007 would be approximately $125
million to $180 million. Actual annual levels of MSRs amortization could either
increase or decrease dependent upon changes in interest rates, prepayment
activity, salable production levels and associated levels of mortgage servicing
right assets. At September 30, 2003 intangible assets are as follows.
- ------------------------------------------------------------------------------------------
Intangible Assets
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Amortization
Expense
Gross Carrying Accumulated 9 Months Ended
Amount Amortization 9/30/03
- ------------------------------------------------------------------------------------------
in millions
Mortgage servicing rights $831 $373* $181**
Favorable lease arrangements 67 18 4
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Total $898 $391 $185
==========================================================================================
* Includes a $51.0 million impairment valuation reserve.
** Includes $180.2 million of amortization and impairment charges related to
residential mortgage activity and $.6 million related to commercial
mortgage activity
3. Related Party Transactions
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The Company is owned by HSBC North America Inc. (HNAI), an indirect wholly owned
subsidiary of HSBC Holdings plc (HSBC). In the normal course of business, the
Company conducts transactions with HSBC, including its 25% or more owned
subsidiaries (HSBC Group). HSBC Group includes Household International, Inc.
(Household) acquired by HSBC in the first quarter of 2003. These transactions
occur at prevailing market rates and terms. The following table presents related
party balances and the total income and expense generated by those transactions.
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September 30, December 31,
2003 2002
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in millions
Assets:
Interest bearing deposits with banks $ 144 $ 130
Loans 393 338
Other 23 38
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Total assets $ 560 $ 506
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Liabilities:
Deposits $6,890 $6,140
Short-term borrowings 601 267
Other 386 349
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Total liabilities $7,877 $6,756
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9.
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Nine months ended September 30, 2003 2002
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in millions
Interest income $ 14 $ 21
Interest expense 71 63
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At September 30, 2003 and December 31, 2002, the aggregate notional amounts of
all derivative contracts with other HSBC affiliates were $135 billion and $88
billion respectively.
Extensions of credit by the Company to other HSBC affiliates are legally
required to be secured by eligible collateral.
Employees of the Company participate in one or more stock option plans sponsored
by HSBC. The Company's share of the expense of the plans for the first nine
months of 2003 and 2002 was $9.5 million and $11.5 million respectively.
The Company also provides awards to key employees in the form of restricted
shares. These awards require the achievement of certain performance targets and
vest from one to three years from the date of the award. Total expense
recognized by the Company for the program for the first nine months of 2003 and
2002 was $28.5 million and $17.7 million respectively.
4. Pledged Assets
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The following table presents pledged assets included in the consolidated balance
sheet.
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Pledged Assets
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September 30, December 31,
2003 2002
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in millions
Interest bearing deposits with banks $ 65 $ 65
Trading assets 1,099 1,770
Securities available for sale 4,436 6,083
Securities held to maturity 1,111 1,607
Loans 400 343
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Total $7,111 $9,868
==============================================================================
5. Litigation
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The Company is named in and is defending legal actions in various jurisdictions
arising from its normal business. None of these proceedings is regarded as
material litigation. In addition, there are certain proceedings related to the
"Princeton Note Matter" that are described below.
In relation to the Princeton Note Matter, as disclosed in the Company's 2002
Annual Report on Form 10-K, two of the noteholders were not included in the
settlement and their civil suits are continuing. The U.S. Government excluded
one of them from the restitution order (Yakult Honsha Co., Ltd.) because a
senior officer of the noteholder was being criminally prosecuted in
10.
Japan for his conduct relating to its Princeton Notes. The senior officer in
question was convicted during September 2002 of various criminal charges related
to the sale of the Princeton Notes. The U.S. Government excluded the other
noteholder (Maruzen Company, Limited) because the sum it is likely to recover
from the Princeton Receiver exceeds its losses attributable to its funds
transfers with Republic New York Securities Corporation as calculated by the
U.S. Government. Both of these civil suits seek compensatory, punitive, and
treble damages pursuant to RICO and assorted fraud and breach of duty claims
arising from unpaid Princeton Notes with face amounts totaling approximately
$125 million. No amount of compensatory damages is specified in either
complaint. These two complaints name the Company, the Bank, and Republic New
York Securities Corporation as defendants. The Company and the Bank have moved
to dismiss both complaints. The motion is fully briefed and sub judice. Mutual
production of documents took place in 2001, but additional discovery proceedings
have been suspended pending the Court's resolution of the motions to dismiss.
11.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
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Performance Overview
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2003 Compared to 2002
The Company reported third quarter 2003 net income of $198.0 million, compared
with $217.0 million in the third quarter of 2002. For the first nine months of
2003, net income was $724.5 million, compared with $627.0 million for the first
nine months of last year. The decrease in net income for the third quarter of
2003 as compared to the third quarter of 2002 reflects lower levels of other
operating income, driven by a reduction of mortgage banking revenue, and
increased operating expenses. Offsetting this reduction was an increase in net
interest income, improved trading results as well as lower provisions for credit
losses. The increase in net income for the first nine months of 2003 as compared
to the comparable period in 2002 reflects growth in net interest income,
improved trading results as well as lower provisions for credit losses.
The quarterly and year to date increases in net interest income growth were
driven by a larger balance sheet, a more favorable balance sheet mix, as well as
strong treasury and mortgage banking interest spreads resulting from
historically low interest rates and a steep yield curve. The quarterly and year
to date increases in trading revenues include solid growth in the derivatives
business and improved results in the foreign exchange business. Provisions for
credit losses declined as credit quality continued to improve during the third
quarter of 2003.
There was a quarterly and year to date reduction in mortgage banking revenue.
These reductions were driven by lower levels of servicing related income which
were partially offset by increases in originations and sales related income. The
results of the Company also reflect a quarterly and year to date increase in
operating expenses when compared to the third quarter and first nine months of
2002. The increases in operating expenses are due to higher levels of salaries
and employee benefit costs, reflecting costs associated with the wealth and tax
advisory services business which commenced activity during the third quarter of
2002, increased pension and fringe benefit costs and higher levels of
performance related incentive compensation. During the third quarter of 2003
severance expenses were recorded for costs related to expense reduction
initiatives, global resourcing moves and Household integration efforts. An
increase in the effective tax rate also adversely impacted net income for the
first nine months of 2003 as compared to last year.
Forward-Looking Statements
This report includes forward-looking statements. Statements that are not
historical facts, including statements about management's beliefs and
expectations, are forward-looking statements and involve inherent risks and
uncertainties. A number of important factors could cause actual results to
12.
differ materially from those contained in any forward-looking statements. Such
factors include, but are not limited to: sharp and/or rapid changes in interest
rates; significant changes in the economic conditions which could materially
change anticipated credit quality trends and the ability to generate loans;
technology changes and challenges; significant changes in accounting, tax or
regulatory requirements; consumer behavior; marketplace perceptions of the
Company's reputation and competition in the geographic and business areas in
which the Company conducts its operations.
13.
HSBC USA Inc.
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CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES*
Third Quarter 2003 Third Quarter 2002
Balance Interest Rate Balance Interest Rate
- -------------------------------------------------------------------------------------------------------------------
in millions
Assets
Interest bearing deposits with banks $ 1,910 $ 6.6 1.38% $ 1,110 $ 8.4 2.99%
Federal funds sold and securities
purchased under resale agreements 4,088 11.3 1.09 5,747 26.5 1.83
Trading assets 11,892 29.9 1.01 11,167 44.2 1.58
Securities 19,448 222.1 4.53 17,959 233.1 5.15
Loans
Domestic
Commercial 16,647 203.6 4.85 16,351 218.7 5.31
Consumer
Residential mortgages 20,441 276.0 5.40 19,319 309.5 6.41
Other consumer 3,076 62.0 8.01 2,899 67.2 9.20
- -------------------------------------------------------------------------------------------------------------------
Total domestic 40,164 541.6 5.35 38,569 595.4 6.12
International 3,408 32.2 3.75 3,065 36.0 4.66
- -------------------------------------------------------------------------------------------------------------------
Total loans 43,572 573.8 5.22 41,634 631.4 6.02
- -------------------------------------------------------------------------------------------------------------------
Other ** 3.9 ** ** 4.9 **
- -------------------------------------------------------------------------------------------------------------------
Total earning assets 80,910 $847.6 4.16% 77,617 $948.5 4.85%
- -------------------------------------------------------------------------------------------------------------------
Allowance for credit losses (474) (547)
Cash and due from banks 2,648 1,958
Other assets 8,745 7,357
- -------------------------------------------------------------------------------------------------------------------
Total assets $ 91,829 $ 86,385
===================================================================================================================
Liabilities and Shareholders' Equity
Deposits in domestic offices
Savings deposits $ 25,602 $ 44.4 0.69% $ 21,202 $ 54.2 1.01%
Other time deposits 9,665 50.2 2.06 12,689 81.8 2.56
Deposits in foreign offices 19,374 55.9 1.14 17,952 99.9 2.21
- -------------------------------------------------------------------------------------------------------------------
Total interest bearing deposits 54,641 150.5 1.09 51,843 235.9 1.81
- -------------------------------------------------------------------------------------------------------------------
Short-term borrowings 8,149 12.8 0.62 10,807 58.5 2.15
Long-term debt 3,725 49.6 5.28 3,640 52.6 5.74
- -------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities 66,515 $212.9 1.27% 66,290 $347.0 2.08%
- -------------------------------------------------------------------------------------------------------------------
Interest rate spread 2.89% 2.77%
- -------------------------------------------------------------------------------------------------------------------
Noninterest bearing deposits 6,628 5,540
Other liabilities 11,116 7,343
Total shareholders' equity 7,570 7,212
- -------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 91,829 $ 86,385
===================================================================================================================
Net yield on average earning assets 3.11% 3.07%
Net yield on average total assets 2.74 2.76
===================================================================================================================
* Interest and rates are presented on a taxable equivalent basis.
** Other relates to interest earned on Federal Reserve Bank and Federal Home
Loan Bank stock included in other assets.
14.
HSBC USA Inc.
- --------------------------------------------------------------------------------
CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES*
Nine Months 2003 Nine Months 2002
Balance Interest Rate Balance Interest Rate
- ---------------------------------------------------------------------------------------------------------------------------
in millions
Assets
Interest bearing deposits with banks $ 1,668 $ 19.3 1.55% $ 2,346 $ 47.5 2.71%
Federal funds sold and securities
purchased under resale agreements 4,359 41.5 1.27 5,431 74.6 1.84
Trading assets 12,445 104.4 1.12 10,445 118.8 1.52
Securities 19,091 685.0 4.80 18,314 728.1 5.32
Loans
Domestic
Commercial 16,563 612.7 4.95 16,441 626.5 5.09
Consumer
Residential mortgages 20,667 874.5 5.64 19,062 941.4 6.59
Other consumer 3,011 187.8 8.34 2,982 204.7 9.18
- ---------------------------------------------------------------------------------------------------------------------------
Total domestic 40,241 1,675.0 5.56 38,485 1,772.6 6.16
International 3,198 94.9 3.97 3,320 125.0 5.03
- ---------------------------------------------------------------------------------------------------------------------------
Total loans 43,439 1,769.9 5.45 41,805 1,897.6 6.07
- ---------------------------------------------------------------------------------------------------------------------------
Other ** 17.6 ** ** 16.6 **
- ---------------------------------------------------------------------------------------------------------------------------
Total earning assets 81,002 $2,637.7 4.35% 78,341 $2,883.2 4.92%
- ---------------------------------------------------------------------------------------------------------------------------
Allowance for credit losses (493) (530)
Cash and due from banks 2,452 1,972
Other assets 7,905 7,509
- ---------------------------------------------------------------------------------------------------------------------------
Total assets $ 90,866 $ 87,292
===========================================================================================================================
Liabilities and Shareholders' Equity
Deposits in domestic offices
Savings deposits $ 24,414 $ 144.4 0.79% $ 20,815 $ 158.7 1.02%
Other time deposits 10,553 171.5 2.17 13,375 286.2 2.86
Deposits in foreign offices 19,208 195.2 1.36 18,901 320.1 2.26
- ---------------------------------------------------------------------------------------------------------------------------
Total interest bearing deposits 54,175 511.1 1.26 53,091 765.0 1.93
- ---------------------------------------------------------------------------------------------------------------------------
Short-term borrowings 9,207 71.3 1.04 10,966 177.3 2.16
Long-term debt 3,714 155.3 5.59 3,889 170.7 5.87
- ---------------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities 67,096 $ 737.7 1.47% 67,946 $1,113.0 2.19%
- ---------------------------------------------------------------------------------------------------------------------------
Interest rate spread 2.88% 2.73%
- ---------------------------------------------------------------------------------------------------------------------------
Noninterest bearing deposits 6,261 5,511
Other liabilities 10,035 6,663
Shareholders' equity 7,474 7,172
- ---------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 90,866 $ 87,292
===========================================================================================================================
Net yield on average earning assets 3.14% 3.02%
Net yield on average total assets 2.80 2.71
===========================================================================================================================
* Interest and rates are presented on a taxable equivalent basis.
** Other relates to interest earned on Federal Reserve Bank and Federal Home
Loan Bank stock included in other assets.
15.
Net Interest Income
- --------------------------------------------------------------------------------
2003 Compared to 2002
Net interest income for the third quarter of 2003 was $629.2 million compared
with $595.1 million for the third quarter of 2002, an increase of 6%. For the
first nine months of 2003, net interest income increased almost 8% to $1,883.3
million compared with $1,751.1 million for the first nine months of 2002. A
better yielding mix of loans, securities and deposits on the balance sheet and
lower funding costs contributed to the increases in net interest income. Average
residential mortgages outstanding grew $1.1 billion and $1.6 billion for the
third quarter and the first nine months of 2003 respectively, as compared with
the same periods of 2002. The low interest rate environment continued to
stimulate consumers to refinance mortgages and purchase residential property.
There has also been a decrease in lower margin large corporate loans. The
Company experienced over a $4.4 billion and $3.6 billion growth in average
savings deposits for third quarter and the first nine months of 2003
respectively, as compared with the same periods of 2002. Due to the low interest
rate environment and the current uncertainty of the equity markets, many
customers have shown a preference to place funds in savings deposits as opposed
to time deposits and mutual funds. The steep yield curve and historically low
interest rates have led to increased interest margins on treasury investments
and in our mortgage banking business.
Forward Outlook
The Company will continue to pursue modest growth in high quality commercial
loans and residential mortgages. Despite recent optimism throughout the
financial markets during the third quarter, larger commercial and institutional
clients continue to remain relatively cautious with regards to implementing
significant new initiatives or generally expanding overall business capacity
ahead of the projected recovery. The Company continues to solidify its lending
relationships with these customers and is exploring opportunities to expand its
overall client base within selected sectors where credit quality has stabilized.
Our commercial middle market customers are displaying more optimism towards the
economy. More of these customers are considering additional commitments of funds
for modest expansion, including selected acquisitions. This optimism is less
prevalent among our Upstate New York customers. Commercial real estate related
lending levels should continue to be stable. The ultimate level of activity in
the residential mortgage portfolio will depend on the interest rate environment
and the Company's appetite for additional mortgage products on the balance
sheet.
The returns relative to larger corporate and institutional clients are expected
to remain stable and at the current favorable level for the remainder of the
year. Interest margins for commercial middle market loans are expected to be
stable in the near term.
16.
The Company is expected to continue to benefit from the historically steep yield
curve for the remainder of 2003. However, if the yield curve flattens, interest
margins are likely to shrink. (See Quantitative and Qualitative Disclosures
About Market Risk). This margin shrinkage may be dampened by balance sheet
growth or other management actions.
The acquisition of Household by HSBC completed during the first quarter of 2003,
will provide opportunities for future business growth. The Company is currently
exploring opportunities to acquire certain consumer loan assets from Household,
including residential mortgages and MasterCard and Visa and private label credit
cards.
Other Operating Income
- --------------------------------------------------------------------------------
2003 Compared to 2002
Trust Income
Trust income for the third quarter and the first nine months of 2003 as compared
to comparable periods of 2002, was relatively stable. The Company has
experienced business growth related to trust income in its International Private
Banking and Issuer Services units. Offsetting this growth were decreases in the
value of assets managed in personal and employee benefit accounts due to general
equity market conditions. In most cases, the Company's fees are based on the
value of assets managed and/or held.
Service Charges
Service charges of $54.2 million in the third quarter of 2003 were essentially
unchanged from the third quarter of 2002. For the first nine months of 2003 as
compared to the first nine months of 2002, service charges increased $4.5
million to $157.3 million. The year to date increase primarily reflects higher
rates earned on personal and commercial deposit service charges.
Other Fees and Commissions
Other fees and commissions increased approximately $7.1 million in the third
quarter of 2003 as compared to the third quarter of 2002, mainly due to a $6.5
million increase in revenue from wealth and tax advisory services, a business
that commenced activity during the third quarter of 2002. For the first nine
months of 2003, other fees and commissions increased $42.6 million to $333.9
million compared with $291.3 million for the first nine months of 2002. The nine
month increase includes $29.0 million of additional revenue from the wealth and
tax advisory services business. Additionally, year to date increases totaling
approximately $11 million were realized in commercial loan, letter of credit,
trade services and bankcard fees because of increased activity. In the area of
wealth management, there was some slowdown in sales of annuities and mutual
funds associated with the uncertainties affecting the stock market and lower
levels of interest rates.
17.
Other Income
Other income in the third quarter of 2003 was $36.9 million compared to $30.5
million in the third quarter of 2002. The quarter to quarter increase reflects a
$4.2 million increase in revenues from the sale of insurance products and a $2.6
million increase in earnings from equity investments. Over 1,600 professionals
are now licensed to sell insurance and certain annuity products through the
Bank's retail network. For the first nine months of 2003, other income was
$128.7 million, compared with $78.9 million for the first nine months of 2002.
During the second quarter of 2003 the Company received $20.7 million from the
Internal Revenue Service for settlement of interest compensation on a corporate
tax refund for prior years. The majority of the remaining year to date increase
relates to revenues from the sale of insurance products which increased $16.8
million and earnings from equity investments which increased $9.4 million.
Forward Outlook - Trust, Service Charges, Other Fees and Commissions, and
Other Income
The Company will continue to utilize its extensive retail distribution network,
its HSBC Group linkage and its high quality sales and service culture to pursue
revenue growth despite an uncertain economy. Efforts to maximize the
"cross-sell" potential of the existing customer base have shown positive results
to date and will continue to be a key business development theme for the
upcoming year. Expansion of the Company's insurance business will also remain a
strategic initiative.
18.
Mortgage Banking Revenue
The following table presents the components of mortgage banking revenue. The
data in the table includes net interest income earned on assets and liabilities
of the mortgage banking business as well as an allocation of the funding benefit
or cost associated with these balances. The net interest income component is
included in net interest income in the statement of income.
- --------------------------------------------------------------------------------------------------------------
3rd 3rd 9 Months 9 Months
Quarter Quarter Ended Ended
2003 2002 9/30/03 9/30/02
- --------------------------------------------------------------------------------------------------------------
in millions
Net interest income $ 89.1 $ 65.4 $ 277.9 $ 205.2
- --------------------------------------------------------------------------------------------------------------
Servicing:
Servicing fee income 15.2 19.4 49.8 55.3
MSRs amortization and impairment charges (1) (36.9) (67.1) (180.2) (102.4)
Trading - Derivative instruments used to
protect value of MSRs (97.6) 54.0 (83.4) 56.6
Gains on sales of available for sale securities 6.5 -- 22.5 .1
- --------------------------------------------------------------------------------------------------------------
Total servicing related income (expense) (112.8) 6.3 (191.3) 9.6
- --------------------------------------------------------------------------------------------------------------
Originations and sales:
Gains (losses) on sales of mortgages (17.8) 45.9 92.5 94.9
Trading - Forward loan sale commitments 54.6 (77.9) 33.5 (135.3)
- Interest rate lock commitments (1.6) 35.6 (24.3) 44.9
Fair value hedge activity (2) 1.0 -- .4 --
- --------------------------------------------------------------------------------------------------------------
Total originations and sales related income 36.2 3.6 102.1 4.5
- --------------------------------------------------------------------------------------------------------------
Other mortgage income 3.0 2.5 9.0 6.8
- --------------------------------------------------------------------------------------------------------------
Total mortgage banking revenue (expense)
included in other operating income (73.6) 12.4 (80.2) 20.9
- --------------------------------------------------------------------------------------------------------------
Total mortgage banking related revenue $ 15.5 $ 77.8 $ 197.7 $ 226.1
==============================================================================================================
(1) Includes a $34.0 million impairment recovery and a $47.9 million provision
charge for impairment for the third quarter of 2003 and 2002 respectively.
Includes a $24.4 million and a $51.0 million provision charge for
impairment for the first nine months of 2003 and 2002 respectively. The
impairment was recorded in a valuation reserve which has a balance of
$51.0 million and $47.0 million at September 30, 2003 and September 30,
2002 respectively.
(2) Includes SFAS 133 qualifying fair value adjustments related to residential
mortgage banking warehouse fair value hedging activity. In December 2002,
the Company established a qualifying hedge strategy using forward sales
contracts to offset the fair value changes of agency conforming closed
mortgage loans originated for sale.
The increases in net interest income reflect growth in the residential mortgage
portfolio in combination with widening interest rate spreads. Average
residential mortgages outstanding grew $1.1 billion and $1.6 billion for the
third quarter and the first nine months of 2003 respectively, as compared with
the same periods of 2002. The low interest rate environment continued to
stimulate consumers to refinance mortgages and purchase residential property.
The steep yield curve and historically low interest rates have led to increased
interest margins in our mortgage banking business.
19.
Total servicing related income for the third quarter and the first nine months
of 2003 decreased $119.1 million and $200.9 million respectively, compared to
the same periods of 2002. The year to date decrease in servicing related income
reflects an increase in the amortization of mortgage servicing rights (MSRs) and
a provision for impairment. The impairment provision was recorded in a valuation
reserve which has a balance of $51.0 million as of September 30, 2003. The
higher level of MSRs amortization is attributable to the low rate environment
and the associated higher level of mortgage prepayment activity for the first
nine months of 2003. The quarterly and year to date decreases in servicing
related income reflect reductions in trading revenue associated with derivative
instruments used to protect the value of MSRs as compared to the same periods of
2002. Partially offsetting these reductions were gains related to the sale of
certain mortgage backed securities available for sale that were used as
"on-balance sheet" economic hedges of MSRs.
The extreme interest rate volatility experienced throughout 2003 impacted the
value of the derivative instruments used to hedge the value of the servicing
rights. This in conjunction with historically record high prepayment activity in
2003, resulted in servicing related losses for the third quarter and first nine
months of 2003. These losses were partially offset by significant origination
related income over these same timeframes.
Total originations and sales related income for the third quarter and the first
nine months of 2003 increased $32.6 million and $97.6 million respectively,
compared to the same periods of 2002. These increases reflect higher trading
revenues related to forward loan sale commitments and significantly higher
origination volumes. Total mortgage originations for the third quarter of 2003
were $9.8 billion compared to $4.5 billion for the third quarter of 2002. For
the first nine months of 2003, total mortgage originations were $22.8 billion
compared to $14.3 billion for the first nine months of 2002.
Forward Outlook
The Company will continue to pursue organic growth in high quality residential
mortgages. The ultimate level of activity in the residential mortgage portfolio
will depend on the interest rate environment and the Company's appetite for
additional mortgage products on the balance sheet. The acquisition of Household
by HSBC completed during the first quarter of 2003, will provide opportunities
for future business growth. The Company is currently exploring opportunities to
acquire certain consumer loan assets from Household, including residential
mortgages. In conjunction with Household, the Company has instituted a customer
referral program to leverage the strengths of the two entities and increase
overall originations volume. The mortgage banking business is expected to
continue to benefit from the historically steep yield curve for the remainder of
2003. However, if the yield curve flattens, interest margins are likely to
shrink.
20.
The Company will continue to develop its strong national market presence by
leveraging its well developed multi-channeled originations network to position
the business for maximum origination opportunities in any type of housing market
or interest rate environment.
The Company will continue to employ a well developed risk management strategy to
reduce interest rate and prepayment risk by utilizing derivative instruments to
effectively hedge both (a) the mortgage originations and (b) values of MSRs
through different economic cycles and rate environments and within established
guidelines.
Trading Revenues
Trading revenues are generated by the Company's participation in the foreign
exchange, credit derivative and precious metal markets; from trading derivative
contracts, including interest rate swaps and options; from trading securities;
and as a result of certain residential mortgage banking activities.
The following table presents trading related revenues by business. The data in
the table includes net interest income earned on trading instruments, as well as
an allocation of the funding benefit or cost associated with the trading
positions. The trading related net interest income component is not included in
other operating income, but it is included in net interest income. Trading
revenues related to the mortgage banking business are included in mortgage
banking revenue. See analysis of mortgage banking revenue for details.
- -------------------------------------------------------------------------------------
3rd 3rd 9 Months 9 Months
Quarter Quarter Ended Ended
2003 2002 9/30/03 9/30/02
- -------------------------------------------------------------------------------------
in millions
Trading revenues $ 51.7 $ 9.8 $ 212.4 $ 56.9
Net interest income 17.9 22.8 63.8 51.8
- -------------------------------------------------------------------------------------
Trading related revenues $ 69.6 $ 32.6 $ 276.2 $ 108.7
=====================================================================================
Business:
Derivatives and treasury $ 22.8 $ (.1) $ 138.1 $ 13.2
Foreign exchange 31.7 14.7 70.7 25.1
Precious metals 12.6 14.8 51.7 50.6
Other trading 2.5 3.2 15.7 19.8
- -------------------------------------------------------------------------------------
Trading related revenues $ 69.6 $ 32.6 $ 276.2 $ 108.7
=====================================================================================
21.
2003 Compared to 2002
Total trading related revenues were $69.6 million in the third quarter of 2003
compared to $32.6 million in the third quarter of 2002. Derivatives and treasury
trading revenue increases in the third quarter of 2003 are primarily the result
of mark to market gains on "non SFAS 133 qualifying" economic hedges of the
Company's investment portfolio, as opposed to mark to market losses in the prior
year's quarter. The Company also had higher proprietary trading revenue in
corporate and other securities, offset by lower proprietary trading revenue in
interest rate derivatives. The increase in foreign exchange trading revenue in
the third quarter of 2003 is due to increased client activity and the absence of
trading losses that impacted the prior year's quarter. The decrease in precious
metals trading revenue in the third quarter of 2003 is the result of adverse
movements in precious metals interest rates offset by increased revenue from
client activity.
Total trading related revenues were $276.2 million for the nine months ended
September 30, 2003 as compared to $108.7 million for the nine months ended
September 30, 2002. The increase in derivatives and treasury trading revenue in
the first nine months of 2003 is due to increased client activity in interest
rate equity and credit derivatives, higher net interest income of the Company's
investment portfolio, higher proprietary trading revenue and mark to market
gains on "non SFAS 133 qualifying" economic hedges of the Company's investment
portfolio, as opposed to mark to market losses in the nine months ended
September 30, 2002. The increase in foreign exchange trading revenue for the
first nine months of 2003 is due to increased client activity and proprietary
trading gains as opposed to foreign exchange trading losses in the first nine
months of 2002. The increase in precious metals trading revenue in the first
nine months of 2003 is principally due to increased client activity offset by
lower proprietary trading gains.
Forward Outlook
The Company expects to continue to build and improve its capabilities in foreign
exchange, credit and interest rate derivatives and precious and base metals to
expand its client franchise and grow related revenues. However, these revenues
are subject to market factors, among other things, and may vary significantly
from reporting period to reporting period. During the first quarter of 2003,
HSBC acquired Household. The Company has entered into certain derivative
contracts with Household subsequent to the acquisition in support of its
treasury and capital markets needs. These transactions are included in trading
related revenues above and the related party disclosures in Note 3. The Company
expects to expand its derivatives business with Household.
22.
Security Gains, Net
Security gains were $2.2 million for the third quarter of 2003, compared to
$16.1 million for the third quarter of 2002. For the first nine months of 2003,
security gains were $51.2 million compared to $120.3 million for the same period
of 2002. Certain Latin American securities were sold during the first nine
months of 2003 in order to reduce the credit risk of the Company, resulting in
$17.6 million of gains. The remainder of the security gains in 2003 primarily
related to transactions that adjusted the average life and interest rate profile
of the Company's available for sale securities holdings. Securities gains
related to the mortgage banking securities sold that were acting as "on-balance
sheet" economic hedges of MSRs are included in mortgage banking revenue.
Security gains for the first nine months of 2002 included gains on sales of
mortgage-backed, U.S. Treasury and Latin American securities. The Company sold
the securities to adjust to interest rate changes and/or reduce its credit risk.
Operating Expenses
- --------------------------------------------------------------------------------
2003 Compared to 2002
Total operating expenses increased $65.4 million and $121.5 million for the
third quarter and nine months ended September 30, 2003 respectively, as compared
to the same periods for 2002. These increases reflect higher costs associated
with salaries and employee benefits and severance expense, as noted below.
Personnel costs related to the wealth and tax advisory services business, which
commenced activity during the third quarter of 2002, accounted for $5.5 million
and $31.0 million of the increases for the third quarter and first nine months
of 2003 respectively, as compared to the same periods of 2002. During the third
quarter, approximately $28 million in severance accruals were recorded for the
estimated cost of expense reduction initiatives, global resourcing moves and
Household integration efforts. For the first nine months of 2003, total
severance related expense was $37.2 million, a $33 million increase over the
comparable period of 2002. Higher costs related to certain volume driven and
revenue driven incentive compensation programs also contributed approximately
$11 million and $27 million respectively, to the quarterly and year to date
expense increases in personnel costs. While fringe benefit costs were down for
the third quarter of 2003, year to date fringe benefit costs increased $7.8
million, primarily due to higher pension and health care costs.
Other expenses related to the Company's insurance business increased
approximately $3 million for the third quarter and $8 million year to date as
compared to the same periods in 2002. These increases reflect higher claim
expenses associated with continued growth in our insurance business and are more
than offset by increases in insurance related other income. See comments related
to other income. The quarterly and year to date increases in other expenses also
reflect costs incurred by the Company to enhance its compliance with anti-money
laundering requirements. See Part II - Other Information, Item 5 - Other
Information.
23.
Forward Outlook
The Company is actively pursuing several initiatives to reduce its overall
expense base including improving efficiency, eliminating redundancy and lowering
the cost of traditional delivery channels.
As a member of a global organization, the Company has the opportunity to gain
cost advantages through the utilization of human, technological and operational
resources in low cost environments. The HSBC Group operates global processing
centers in India, China and Malaysia. The Company has commenced the migration of
certain operational and customer service activities to India and intends to
continue to do so over the next few years. Exit costs associated with this
global resourcing move are included in the third quarter 2003 severance expense.
A qualified team is in place to manage the transition of the work ensuring no
negative customer impact and the sensitive handling of affected employees.
There are various other expense reduction initiatives being pursued relative to
Household as the two companies continue to re-evaluate processes, practices, and
procedures. These initiatives will result in the combining or realigning of
certain operations to reduce duplication, and will leverage best practices to
take advantage of synergies of the integrated organization. Specific initiatives
include improving efficiencies and economies of scale relative to information
technology and pursuing opportunities to leverage the Company's purchasing power
with Household to reduce health care and insurance costs.
Income Taxes
- --------------------------------------------------------------------------------
2003 Compared to 2002
The effective tax rate was 36.5% in the third quarter of 2003 compared with
37.6% in the same period of 2002. The effective tax rate was 38.0% in the first
nine months of 2003 compared with 37.0% in the first nine months of 2002. The
increase in the year to date effective tax rate is primarily attributable to a
substantial increase in taxable income. The net deferred tax position at
September 30, 2003 was a liability of $273 million compared with a liability of
$209 million at December 31, 2002.
24.
Credit Quality
- --------------------------------------------------------------------------------
The following table provides a summary of the allowance for credit losses.
- -------------------------------------------------------------------------------------------------------------------
3rd 3rd 9 Months Year 9 Months
Quarter Quarter Ended Ended Ended
2003 2002 9/30/03 12/31/02 9/30/02
- -------------------------------------------------------------------------------------------------------------------
in millions
Balance at beginning of period $ 475.8 $ 540.3 $ 493.1 $ 506.4 $ 506.4
Allowance related to loans sold -- (.3) (7.8) (2.2) (2.3)
Provision charged (credited) to income (1.3) 39.0 86.2 195.0 168.8
Charge offs:
Commercial 28.8 12.4 103.9 134.4 82.1
Consumer 20.1 18.0 58.4 77.6 57.4
International 8.7 14.6 12.0 28.9 20.3
- -------------------------------------------------------------------------------------------------------------------
Total charge offs 57.6 45.0 174.3 240.9 159.8
- -------------------------------------------------------------------------------------------------------------------
Recoveries on loans charged off:
Commercial 9.8 3.8 21.4 20.6 18.1
Consumer 3.1 2.9 9.3 12.5 9.5
International 5.3 .6 7.2 2.1 .8
- -------------------------------------------------------------------------------------------------------------------
Total recoveries 18.2 7.3 37.9 35.2 28.4
- -------------------------------------------------------------------------------------------------------------------
Total net charge offs 39.4 37.7 136.4 205.7 131.4
- -------------------------------------------------------------------------------------------------------------------
Translation adjustment -- (.3) -- (.4) (.5)
- -------------------------------------------------------------------------------------------------------------------
Balance at end of period $ 435.1 $ 541.0 $ 435.1 $ 493.1 $ 541.0
- -------------------------------------------------------------------------------------------------------------------
The following table provides a summary of credit quality statistics.
- ---------------------------------------------------------------------------------------
September 30, December 31, September 30,
2003 2002 2002
- ---------------------------------------------------------------------------------------
in millions
Nonaccruing Loans
Balance at end of period $ 348.5 $ 387.4 $ 399.0
As a percent of loans outstanding .78% .89% .95%
Allowance Ratios
Allowance for credit losses as
a percent of:
Loans .97% 1.13% 1.28%
Nonaccruing loans 124.86 127.28 135.59
Criticized Assets (1)
Balance at end of period $ 1,441.8 $ 2,210.2 $ 2,265.8
- ---------------------------------------------------------------------------------------
(1) Includes loans graded "special mention", "substandard" or "doubtful".
The provision for credit losses for the quarter ended September 30, 2003 was a
credit of $1.3 million compared with a $39.0 million charge for the quarter
ended September 30, 2002. The provision for credit losses for the first nine
months of 2003 was $86.2 million compared with $168.8 million during the first
nine months of 2002. These decreases reflect continued improvement in the
overall credit quality of the Company's commercial lending portfolios as
evidenced by declining levels of criticized assets and nonaccruing loans.
25.
Total nonaccruing loans decreased by $50.5 million from $399.0 million at
September 30, 2002 to $348.5 million at September 30, 2003 and decreased by
$38.9 million from $387.4 million at December 31, 2002. Criticized asset totals
decreased by $824.0 million to $1,441.8 million at September 30, 2003 from
$2,265.8 million at September 30, 2002 and decreased by $768.4 million from
$2,210.2 million at December 31, 2002. Net charge offs during the third quarter
of 2003 were $39.4 million compared to $37.7 million for the third quarter of
2002. Net charge offs during the first nine months of 2003 were $136.4 million
compared with $131.4 million for the first nine months of 2002.
Key coverage ratios declined from the first nine months of 2002 compared to the
first nine months of 2003, as the allowance for credit losses represented .97%
of total loans and 124.86% of nonaccruing loans at September 30, 2003, versus
1.28% of total loans and 135.59% of nonaccruing loans at September 30, 2002.
These ratios also declined slightly from December 31, 2002 when the allowance
for credit losses represented 1.13% of total loans and 127.28% of nonaccruing
loans, primarily due to a lower level of required reserves and reflecting
improved credit quality.
The Company identified impaired loans totaling $240 million at September 30,
2003, of which $161 million had a related impairment reserve of $91 million. At
September 30, 2002, $295 million of impaired loans were identified, of which
$173 million had a related impairment reserve of $103 million and at December
31, 2002 there were $288 million of impaired loans, $170 million of which had a
related impairment reserve of $89 million.
Forward Outlook
Credit quality in all loan portfolios continues to show signs of stabilization
and improvement. While there are economic and geopolitical issues that can
impact credit quality, the favorable trend is expected to continue at this time.
Although the Company is optimistic, it will continue to monitor closely key
economic indicators and trends including governmental and private sector
spending priorities, consumer confidence, corporate performance and the general
business climate.
Business Segments
- --------------------------------------------------------------------------------
The Company reports and manages its business segments consistently with the line
of business groupings used by HSBC. As a result of HSBC line of business
changes, the Company altered the business segments that it used in 2002 to
reflect the movement of certain domestic private banking activities from the
Personal Financial Services Segment to the Private Banking Segment. Also
activity related to selected commercial customers was moved from the Commercial
Banking Segment to the Corporate, Investment Banking and Markets Segment. Prior
period disclosures as reported in the third quarter 2002 Form 10-Q have been
conformed herein to the presentation of current segments, including methodology
changes related to the transfer pricing of assets and liabilities.
26.
The Company has four distinct segments that it utilizes for management reporting
and analysis purposes. These segments are based upon products and services
offered.
The following describes the segments.
The Personal Financial Services Segment provides a broad range of financial
products and services including installment and revolving term loans, deposits,
branch services, mutual funds, investments and insurance. These products are
marketed to individuals primarily through the branch banking network.
Residential mortgage lending provides loan financing through direct retail and
wholesale origination channels. Mortgage loans are originated through a network
of brokers, wholesale agents and retail origination offices. Servicing is
performed for the individual mortgage holder or on a contractual basis for
mortgages owned by third parties.
The Commercial Banking Segment provides a diversified range of financial
products and services. This segment provides loan and deposit products to small
and middle-market corporations including specialized products such as accounts
receivable and real estate financing. In addition, various credit and trade
related products are offered such as standby facilities, performance guarantees
and acceptances. These products and services are offered through multiple
delivery systems, including the branch banking network.
The Corporate, Investment Banking and Markets Segment is comprised of
Corporate/Institutional Banking (CIB) and Investment Banking and Markets (IBM).
CIB provides deposit and lending functionality to large and multi-national
corporations and banks. U.S. dollar clearing services are offered for domestic
and international wire transfer transactions. Credit and trade related products
such as standby facilities, performance guarantees and acceptances are also
provided to large corporate entities. The IBM component includes treasury and
traded markets. The treasury function maintains overall responsibility for the
investment and borrowing of funds to ensure liquidity, manage interest rate risk
and capital at risk. Traded markets encompasses the trading and sale of foreign
exchange, banknotes, derivatives, precious metals, securities and emerging
markets instruments, both domestically and internationally.
The Private Banking Segment offers a full range of services for high net worth
individuals including deposit, lending, trading, trust and investment
management.
27.
Other Segment includes equity investments in Wells Fargo HSBC Trade Bank and
HSBC Republic Bank (Suisse) S.A. For 2002 this segment includes the liability
related to the Princeton Note Matter recorded in September of 2001 and paid in
January of 2002.
The following summarizes the results for each segment.
- --------------------------------------------------------------------------------------------------------------------------
Corporate,
Personal Investment
Financial Commercial Banking and Private
Services Banking Markets Banking Other Total
- --------------------------------------------------------------------------------------------------------------------------
in millions
Third Quarter 2003
Net interest income (1) $ 296 $ 146 $ 162 $ 29 $ (4) $ 629
Other operating income 16 38 89 56 6 205
- --------------------------------------------------------------------------------------------------------------------------
Total income 312 184 251 85 2 834
Operating expenses (2) 245 102 111 65 -- 523
- --------------------------------------------------------------------------------------------------------------------------
Working contribution 67 82 140 20 2 311
Provision for credit losses (3) 17 (2) (10) (6) -- (1)
- --------------------------------------------------------------------------------------------------------------------------
Income before taxes 50 84 150 26 2 312
- --------------------------------------------------------------------------------------------------------------------------
Average assets 28,051 14,403 46,140 2,954 281 91,829
Average liabilities/equity (4) 31,376 13,483 38,690 8,280 -- 91,829
- --------------------------------------------------------------------------------------------------------------------------
Third Quarter 2002
Net interest income (1) $ 279 $ 155 $ 134 $ 30 $ (3) $ 595
Other operating income 95 37 64 42 11 249
- --------------------------------------------------------------------------------------------------------------------------
Total income 374 192 198 72 8 844
Operating expenses (2) 217 99 90 51 -- 457
- --------------------------------------------------------------------------------------------------------------------------
Working contribution 157 93 108 21 8 387
Provision for credit losses (3) 14 30 (3) (2) -- 39
- --------------------------------------------------------------------------------------------------------------------------
Income before taxes 143 63 111 23 8 348
- --------------------------------------------------------------------------------------------------------------------------
Average assets 25,644 14,909 43,341 2,213 278 86,385
Average liabilities/equity (4) 29,606 12,286 36,129 8,364 -- 86,385
- --------------------------------------------------------------------------------------------------------------------------
(1) Net interest income of each segment represents the difference between
actual interest earned on assets and interest paid on liabilities of the
segment adjusted for a funding charge or credit. Segments are charged a
cost to fund assets (e.g. customer loans) and receive a funding credit for
funds provided (e.g. customer deposits) based on equivalent market rates.
(2) Expenses for the segments include fully apportioned corporate overhead
expenses.
(3) The provision apportioned to the segments is based on the segments' net
charge offs and the change in allowance for credit losses. Credit loss
reserves are established at a level sufficient to absorb the losses
considered to be inherent in the portfolio.
(4) Common shareholder's equity and earnings on common shareholder's equity
are allocated back to the segments based on the percentage of capital
assigned to the business.
Personal Financial Services
Income before taxes for the segment decreased $93 million from the third quarter
of 2002 reflecting lower levels of other operating income and higher levels of
operating expenses partially offset by an increase in net interest income. The
decrease in other operating income was driven by lower levels of mortgage
banking revenue. This reduction was due to lower levels of servicing related
income which was partially offset by increases in originations and sales related
income. The increase in operating expenses reflects severance related accruals
recorded in the third quarter of 2003. The increase in
28.
net interest income was driven by continued growth in residential mortgage
activity, a better yielding mix of deposits and lower funding costs. Average
residential mortgages grew $1.1 billion as the low interest rate environment
continued to stimulate consumers to refinance mortgages and purchase residential
property.
Commercial Banking
Income before taxes for this segment increased $21 million over the third
quarter of 2002, reflecting a lower provision for credit losses which was
partially offset by higher levels of operating expenses. The $32 million
decrease in the provision for credit losses reflects continued improvement in
the overall credit quality of the Company's commercial lending portfolios as
evidenced by declining levels of criticized assets and nonaccruing loans. The
increase in operating expenses reflects higher pension and health insurance
costs and severance related accruals recorded in the third quarter of 2003.
Offsetting these increases were lower operating expenses incurred by the
restructured commercial finance receivables and equipment financing units.
Corporate, Investment Banking and Markets
Income before taxes for the segment increased $39 million over the third quarter
of 2002 driven by improved trading related results and higher levels of net
interest income. The improvement in trading revenue reflects increases in
derivatives and treasury trading and foreign exchange trading revenue. The
increase in derivatives and treasury trading revenue is due to increased client
activity in interest rate and credit derivatives, higher proprietary trading
revenue and mark to market gains on "non SFAS 133 qualifying" economic hedges of
the Company's investment portfolio. The increase in foreign exchange trading
revenue is due to increased client activity and proprietary trading gains. The
above noted increases in trading revenue were partially offset by lower profits
from the sale of available for sale investment securities. The net interest
income growth in this segment was driven by a larger balance sheet and improved
interest spreads resulting from historically low interest rates and a steep
yield curve. The increase in operating expenses reflects higher levels of
performance driven incentive compensation and higher fringe benefit costs.
Private Banking
This segment contributed $26 million to income before taxes compared to $23
million for the same period in 2002. This increase reflects a higher level of
other operating income partially offset by a higher level of operating expenses.
The increase in other operating income includes higher levels of trust income
earned by International Private Banking. The increases in other operating income
and operating expenses also relate to the wealth and tax advisory services, a
business that commenced activity during the third quarter of 2002.
29.
Other
Other segment includes equity investments in Wells Fargo HSBC Trade Bank and
HSBC Republic Bank (Suisse) S.A.
- --------------------------------------------------------------------------------------------------------------------------
Corporate,
Personal Investment
Financial Commercial Banking and Private
Services Banking Markets Banking Other Total
- --------------------------------------------------------------------------------------------------------------------------
in millions
Nine months ended September 30, 2003
Net interest income (1) $ 892 $ 447 $ 467 $ 89 $ (12) $ 1,883
Other operating income 189 117 396 152 19 873
- --------------------------------------------------------------------------------------------------------------------------
Total income 1,081 564 863 241 7 2,756
Operating expenses (2) 710 295 313 182 -- 1,500
- --------------------------------------------------------------------------------------------------------------------------
Working contribution 371 269 550 59 7 1,256
Provision for credit losses (3) 51 34 7 (6) -- 86
- --------------------------------------------------------------------------------------------------------------------------
Income before taxes 320 235 543 65 7 1,170
- --------------------------------------------------------------------------------------------------------------------------
Average assets 27,950 14,225 45,538 2,872 281 90,866
Average liabilities/equity (4) 30,913 13,251 38,598 8,104 -- 90,866
- --------------------------------------------------------------------------------------------------------------------------
Goodwill at September 30, 2003 1,223 533 631 429 -- 2,816
- --------------------------------------------------------------------------------------------------------------------------
Nine months ended September 30, 2002
Net interest income (1) $ 828 $ 433 $ 401 $ 98 $ (9) $ 1,751
Other operating income 275 110 293 97 17 792
- --------------------------------------------------------------------------------------------------------------------------
Total income 1,103 543 694 195 8 2,543
Operating expenses (2) 647 312 279 140 -- 1,378
- --------------------------------------------------------------------------------------------------------------------------
Working contribution 456 231 415 55 8 1,165
Provision for credit losses (3) 51 105 9 4 -- 169
- --------------------------------------------------------------------------------------------------------------------------
Income before taxes 405 126 406 51 8 996
- --------------------------------------------------------------------------------------------------------------------------
Average assets 25,706 14,737 43,610 2,963 276 87,292
Average liabilities/equity (4) 29,956 12,530 35,103 9,683 20 87,292
- --------------------------------------------------------------------------------------------------------------------------
Goodwill at September 30, 2002 1,224 544 635 428 -- 2,831
- --------------------------------------------------------------------------------------------------------------------------
(1) Net interest income of each segment represents the difference between
actual interest earned on assets and interest paid on liabilities of the
segment adjusted for a funding charge or credit. Segments are charged a
cost to fund assets (e.g. customer loans) and receive a funding credit for
funds provided (e.g. customer deposits) based on equivalent market rates.
(2) Expenses for the segments include fully apportioned corporate overhead
expenses.
(3) The provision apportioned to the segments is based on the segments' net
charge offs and the change in allowance for credit losses. Credit loss
reserves are established at a level sufficient to absorb the losses
considered to be inherent in the portfolio.
(4) Common shareholder's equity and earnings on common shareholder's equity
are allocated back to the segments based on the percentage of capital
assigned to the business.
Personal Financial Services
Income before taxes for the segment decreased $85 million from the first nine
months of 2002 reflecting lower levels of other operating income and higher
levels of operating expenses partially offset by an increase in net interest
income. The decrease in other operating income was driven by lower levels of
30.
mortgage banking revenue. This reduction was due to lower levels of servicing
related income which was partially offset by increases in originations and sales
related income. Wealth management fees were also lower, reflecting reduced
demand for retail investment products, weaker consumer confidence and volatile
equity markets. The increase in operating expenses reflects higher pension and
health care insurance costs and severance related accruals recorded in the third
quarter of 2003. The increase in net interest income was driven by continued
growth in residential mortgage activity, a better yielding mix of deposits and
lower funding costs. Average residential mortgages grew over $1.6 billion as the
low interest rate environment continued to stimulate consumers to refinance
mortgages and purchase residential property.
Commercial Banking
Income before taxes for this segment increased $109 million over last year
reflecting a decrease in the provision for credit losses and an increase in net
interest income. The decrease in the provision for credit losses reflects
continued improvement in the overall credit quality of the Company's commercial
lending portfolios as evidenced by declining levels of criticized assets and
nonaccruing loans. The increase in net interest income reflects lower funding
costs and loan and fee income growth achieved by the Company's real estate
lending unit. This net interest income growth was partially offset by revenue
declines in the restructured commercial finance receivables and equipment
financing units. The restructuring of the commercial finance receivables and
equipment financing units led to lower operating expenses. These cost savings
were offset by higher pension and health care insurance costs and severance
related accruals recorded in the third quarter of 2003.
Corporate, Investment Banking and Markets
Income before taxes for the segment increased $137 million over the first nine
months of 2002 driven by higher levels of trading revenue and increases in net
interest income. The year to date improvement in trading revenue primarily
relates to derivative and treasury trading and foreign exchange trading revenue.
The increase in derivatives and treasury trading revenue in the first nine
months of 2003 is due to increased client activity in interest rate and credit
derivatives, higher proprietary trading revenue and mark to market gains on "non
SFAS 133 qualifying" economic hedges of the Company's investment portfolio as
opposed to mark to market losses in the nine months ended September 30, 2002.
The increase in foreign exchange trading revenue for the first nine months of
2003 is due to increased client activity and proprietary trading gains. The
above noted increases in trading revenue were partially offset by lower profits
from the sale of available for sale investment securities. The net interest
income growth in this segment was driven by a larger balance sheet and improved
interest spreads resulting from historically low interest rates and a steep
yield curve. The increase in operating expenses reflects higher levels of
performance driven incentive compensation and higher fringe benefit costs.
31.
Private Banking
This segment contributed $65 million to income before taxes in the first nine
months of 2003 compared with $51 million in the same period of 2002. The pretax
increase reflects an increase in other operating income partially offset by
higher levels of operating expenses. The increase in other operating income
includes $29 million of additional revenue from wealth and tax advisory
services, a business that commenced activity during the third quarter of 2002.
Global private banking revenues increased in the first nine months of 2003 as a
result of the repricing of services and higher levels of investment sales to
international clients. The increase in operating expenses as compared to 2002
includes approximately $36 million related to the wealth and tax advisory
services business.
Other
Other segment includes equity investments in Wells Fargo HSBC Trade Bank and
HSBC Republic Bank (Suisse) S.A. For 2002 this segment includes the liability
related to the Princeton Note Matter recorded in September of 2001 and paid in
January of 2002.
Derivative Instruments and Hedging Activities
- --------------------------------------------------------------------------------
The Company is party to various derivative financial instruments as an end user
(1) for asset and liability management purposes; (2) in order to offset the risk
associated with changes in the value of various assets and liabilities accounted
for in the trading account; (3) to protect against changes in value of its
mortgage servicing rights portfolio, and (4) for trading in its own account.
The Company is also an international dealer in derivative instruments
denominated in U.S. dollars and other currencies which include futures,
forwards, swaps and options related to interest rates, foreign exchange rates,
equity indices, commodity prices and credit, focusing on structuring of
transactions to meet clients' needs.
The Company enters into certain derivative contracts for purely trading purposes
in order to realize profits from short-term movements in interest rates,
commodity prices, foreign exchange rates and credit spreads. In addition,
certain contracts do not qualify as SFAS 133 hedges and are accounted for on a
mark to market basis through current earnings even though they were not acquired
for trading purposes.
By using derivative instruments, the Company is exposed to credit and market
risk. If the counterparty fails to perform, credit risk is equal to the fair
value gain in a derivative. When the fair value of a derivative contract is
positive, this generally indicates that the counterparty owes the Company, and,
therefore, creates a repayment risk for the Company. When the fair value of a
derivative contract is negative, the Company owes the counterparty and,
therefore, it has no repayment risk.
32.
The Company minimizes the credit (or repayment) risk in derivative instruments
by entering into transactions with high quality counterparties including other
members of the HSBC Group. Counterparties include financial institutions,
government agencies, both foreign and domestic, corporations, funds (mutual
funds, hedge funds, etc.), insurance companies and private clients. These
counterparties are subject to regular credit review by the Company's credit risk
management department. The Company also requires that most derivative contracts
be governed by an International Swaps and Derivatives Association Master
Agreement. Depending on the type of counterparty and the level of expected
activity, bilateral collateral arrangements may be required as well.
Market risk is the adverse effect that a change in interest rates, currency, or
implied volatility rates has on the value of a financial instrument. The Company
manages the market risk associated with interest rate and foreign exchange
contracts by establishing and monitoring limits as to the types and degree of
risk that may be undertaken. The Company measures this risk daily by using Value
at Risk (VAR) and other methodologies.
The Company's Asset and Liability Policy Committee is responsible for monitoring
and defining the scope and nature of various strategies utilized to manage
interest rate risk that are developed through its analysis of data from
financial simulation models and other internal and industry sources. The
resulting hedge strategies are then incorporated into the Company's overall
interest rate risk management and trading strategies.
A summary of the notional amount of the Company's derivative financial
instruments follows.
- ------------------------------------------------------------------------------
September 30, December 31,
2003 2002
- ------------------------------------------------------------------------------
in millions
Interest rate:
Futures and forwards $ 112,859 $ 73,640
Swaps 513,177 242,502
Options written 158,979 106,540
Options purchased 171,109 108,710
- ------------------------------------------------------------------------------
956,124 531,392
- ------------------------------------------------------------------------------
Foreign exchange:
Swaps, futures and forwards 131,605 80,042
Options written 16,191 4,101
Options purchased 16,851 4,875
Spot 27,995 5,258
- ------------------------------------------------------------------------------
192,642 94,276
- ------------------------------------------------------------------------------
Other (1):
Swaps, futures and forwards 37,049 28,011
Options written 7,531 5,059
Options purchased 7,431 5,042
Credit derivatives 25,628 11,058
- ------------------------------------------------------------------------------
77,639 49,170
- ------------------------------------------------------------------------------
Total $1,226,405 $674,838
==============================================================================
(1) Other includes commodities, equities and precious metals.
33.
The notional amount of derivative financial instruments only provides an
indicator of the transaction volume in these types of instruments. It does not
represent the Company's exposure to market or credit risks under these
contracts. The total credit risk exposure of derivative financial instruments
was $15.6 billion and $8.4 billion at September 30, 2003 and December 31, 2002
respectively. This credit risk exposure is calculated in a manner consistent
with regulatory risk-based capital standards.
Liquidity Management
- --------------------------------------------------------------------------------
Liquidity is managed to provide the ability to generate cash to meet lending,
deposit withdrawal and other commitments at a reasonable cost in a reasonable
amount of time, while maintaining routine operations and market confidence. The
Asset and Liability Policy Committee is responsible for the development and
implementation of related policies and procedures to ensure that the minimum
liquidity ratios and a strong overall liquidity position are maintained.
In carrying out this responsibility, the Asset and Liability Policy Committee
projects cash flow requirements and determines the optimal level of liquid
assets and available funding sources to have at the Company's disposal, with
consideration given to anticipated deposit and balance sheet growth, contingent
liabilities, and the ability to access short-term wholesale funding markets. In
addition, the Committee must monitor deposit and funding concentrations in terms
of overall mix and to avoid undue reliance on individual funding sources and
large deposit relationships. It must also maintain a liquidity management
contingency plan, which identifies certain potential early indicators of
liquidity problems, and actions which can be taken both initially and in the
event of a liquidity crisis, to minimize the long-term impact on the Company's
business and customer relationships.
Deposit accounts from a diverse mix of "core" retail, commercial and public
sources represent a significant, cost-effective source of liquidity under normal
operating conditions. The Company's ability to regularly attract wholesale funds
at a competitive cost is enhanced by strong ratings from the major credit
ratings agencies. At September 30, 2003, the Company and its principal operating
subsidiary, HSBC Bank USA, maintained the following long and short-term debt
ratings.
Short-Term Debt Long-Term Debt
------------------------------ ----------------------------
Moody's S&P Fitch Moody's S&P Fitch
------- --- ----- ------- --- -----
HSBC USA Inc. P-1 A-1 F1+ A1 A+ AA-
HSBC Bank USA P-1 A-1+ F1+ Aa3 AA- AA-
The Company's shelf registration statement filed with the United States
Securities and Exchange Commission has $825 million available under which it may
issue debt and equity securities and has ready access to the capital markets for
long-term funding through the issuance of registered debt. In addition, the
Company has an unused $500 million line of credit with HSBC Bank plc and, as a
member of the New York Federal Home Loan Bank, has a
34.
potential secured borrowing facility in excess of $5 billion. Off-balance sheet
special purpose vehicles or other off-balance sheet mechanisms are not utilized
as a source of liquidity or funding.
Assets, principally consisting of a portfolio of highly rated investment
securities in excess of $19 billion, approximately $6 billion of which, based on
anticipated cash flows, is scheduled to mature within the next twelve months, a
liquid trading portfolio of approximately $11 billion, and residential mortgages
are a primary source of liquidity to the extent that they can be sold or used as
collateral for borrowing. The economics and long-term business impact of
obtaining liquidity from assets must be weighed against the economics of
obtaining liquidity from liabilities, along with consideration given to the
associated capital ramifications of these two alternatives. Currently, assets
would be used to supplement liquidity derived from liabilities only in a crisis
scenario.
It is the policy of the Bank to maintain both primary and secondary collateral
in order to ensure precautionary borrowing availability from the Federal
Reserve. Primary collateral is that which is physically maintained at the
Federal Reserve, and serves as a safety net against any unexpected funding
shortfalls that may occur. Secondary collateral is collateral that is acceptable
to the Federal Reserve, but is not maintained there. If unutilized borrowing
capacity were to be low, secondary collateral would be identified and maintained
as necessary.
The Company projects, as part of normal ongoing contingency planning, that in
the event of a severe liquidity problem there would be sources of cash exceeding
projected uses of cash by more than $9 billion, assuming that the Company would
not have access to the wholesale funds market. In addition, the Company
maintains residential mortgages and other eligible collateral at the Federal
Reserve that could provide additional liquidity if needed.
35.
Off-Balance Sheet Arrangements
- --------------------------------------------------------------------------------
Standby Letters of Credit
A standby letter of credit is issued to third parties for the benefit of a
customer and is essentially a guarantee that the customer will perform, or
satisfy some obligation, under a contract. It irrevocably obligates the Company
to pay a third-party beneficiary when a customer either: (1) in the case of a
performance standby letter of credit, fails to perform some contractual
non-financial obligation or, (2) in the case of a financial standby letter of
credit, fails to repay an outstanding loan or debt instrument. The issuance of a
standby letter of credit is subject to the Company's credit approval process and
collateral requirements.
Fees are charged for issuing letters of credit commensurate with the customer's
credit evaluation and the nature of any collateral. Deferred fees, representing
the fair value of the Company's "stand ready obligation to perform" under these
guarantees, included in other liabilities at September 30, 2003 were $8.5
million. Also included in other liabilities at September 30, 2003 and December
31, 2002 was an allowance for credit losses relating to unfunded standby letters
of credit of $24.8 million and $37.4 million respectively.
Loan Sales with Recourse
The Company securitizes and sells assets, generally without recourse. In prior
years, the Company's mortgage banking subsidiary has sold residential mortgage
loans with recourse to it upon borrower default, with partial indemnification
from third parties.
Credit Derivatives
The Company enters into credit derivative contracts to provide value-added
solutions to the risk management and investment needs of its customers, as well
as on its own behalf. Credit derivatives are arrangements that allow one party
(the "beneficiary") to transfer the credit risk of a "reference asset," to
another party (the "guarantor"). This arrangement allows the guarantor to assume
the credit risk associated with the reference asset without directly purchasing
it. The beneficiary agrees to pay the guarantor a specified fee. In return, the
guarantor agrees to pay the beneficiary an agreed upon amount if there is a
default during the term of the contract.
In accordance with its policy, the Company offsets virtually all of the market
risk it assumes in selling credit guarantees through a credit derivative
contract with another counterparty. Credit derivatives, although having
characteristics of guarantees, are accounted for as derivative instruments and
are carried at fair value. The commitment amount is the maximum amount that the
Company could be required to pay, without consideration of the approximately
equal amount receivable from third parties.
36.
Securities Lending Indemnifications
In securities lending transactions, the Company lends customers securities as an
agent to third party borrowers. The Company indemnifies the customer against the
risk of loss if the third party borrower fails to return the securities. The
Company obtains collateral from the borrower with a market value exceeding the
value of the loaned securities.
The following table summarizes, at September 30, 2003, the maximum potential
amount of future payments the Company could be required to make under the
various transactions discussed above if there were a total default by the
guaranteed parties. These amounts do not take into consideration any recoveries
under indemnification provisions or from collateral held or pledged.
- ---------------------------------------------------------------------------------------------------------
One Over One Over
Year Through Five
September 30, 2003 or Less Five Years Years Total
- ---------------------------------------------------------------------------------------------------------
in millions
Standby letters of credit, net of participations $3,270 $ 883 $139 $ 4,292(1)
Loan sales with recourse -- 2 17 19(2)
Credit derivatives 497 12,507 516 13,520(3)
Securities lending indemnifications 2,232 -- -- 2,232(4)
- ---------------------------------------------------------------------------------------------------------
Total $5,999 $13,392 $672 $20,063
=========================================================================================================
(1) Includes $339 million issued for the benefit of related parties.
(2) $14 million of this amount is indemnified by third parties.
(3) Includes $472 million issued for the benefit of related parties.
(4) The Company holds collateral of $2,269 million to support these
indemnifications.
Special Purpose and Variable Interest Entities
Refer to the disclosure under the caption "Recently Issued Accounting Standards"
for a discussion of Financial Accounting Standards Board Interpretation No. 46,
Consolidation of Variable Interest Entities (FIN 46).
Commercial Paper Conduit
An affiliated member of the HSBC Group (HSBC affiliate) supports the financing
needs of customers by facilitating their access to the commercial paper markets.
These markets provide an attractive financing alternative for these customers.
Specifically, pools of customers' assets, typically high-grade corporate and
consumer receivables, are sold to a commercial paper financing entity, which in
turn issues high grade, independently rated short-term asset backed commercial
paper that is collateralized by such assets. The HSBC affiliate facilitates
these transactions and bills and collects fees from the financing entity for the
services it provides. In its role as administrator of this specialized financing
entity, the HSBC affiliate structures financing transactions for customers such
that the receivables
37.
financed through the financing entity are appropriately diversified and credit
enhanced to support the issuance of asset backed commercial paper. Neither the
HSBC affiliate nor the Company service the assets or transfer their own
receivables into the financing entity.
The Company and other banks provide committed liquidity facilities, which mature
within one year, in the form of either loan or asset purchase commitments, in
support of each transaction in the financing entity. In addition, the Company
provides a standby letter of credit as a program wide credit enhancement to the
financing entity. The Company collects fees from the financing entity for both
the liquidity facility and the standby letter of credit. Credit risk is managed
on these commitments by subjecting them to the Company's normal underwriting and
risk management processes.
During the second quarter of 2003, the financing entity issued Capital Notes,
risk transferring instruments in an amount greater than a majority of the
expected losses as defined in FIN 46. 100% of the Capital Notes in the financing
entity were sold to a third party unrelated to the HSBC Group. These notes carry
a fixed rate of return and entitle the note holders to approval and/or voting
rights with regard to certain business matters, which may arise in the business
of the financing entity. As a result, the Capital Notes holders are in the first
position to absorb more than a majority of the expected losses of the financing
entity, if they occur. Therefore, neither the Company nor its affiliated member
is required to consolidate the financing entity as the primary beneficiary in
accordance with FIN 46.
At September 30, 2003 and December 31, 2002, the financing entity had total
commitments to customers of $2,520.0 million and $1,250.0 million, and total
investments of $1,495.3 million and $792.0 million respectively. At September
30, 2003 and December 31, 2002, the Company had liquidity commitments and
standby letters of credit, which also represents the Company's maximum exposure
to loss, to the financing entity of $1,495.3 million and $685.0 million
respectively. Assets in the financing entity are principally trade receivables,
auto loans and credit card receivables.
Trust Certificates
The HSBC affiliate also organizes trusts that are special purpose entities
(SPEs) that issue floating rate certificates backed by the underlying assets of
the trusts, which the SPEs purchase primarily from insurance companies. The
Company's relationship with the SPEs is primarily as a counterparty to the SPEs'
derivative transactions (interest rate and credit default swaps). The derivative
transactions are accounted for in accordance with SFAS 133 and are carried at
fair value. At September 30, 2003 and December 31, 2002 the SPEs had total
assets of $850.1 million and $412.0 million respectively. At September 30, 2003,
the Company's maximum exposure to loss from these unconsolidated trust
transactions, which are comprised of investments in the trusts and the mark to
market on the derivative transactions, was $355.7 million. These entities have
been determined to be variable interest entities (VIEs) as defined by FIN 46.
The Company is the primary beneficiary
38.
of a trust entity and has consolidated $6.7 million in net trading assets as a
result. This trust entity has total assets of $10.0 million at September 30,
2003. Creditors of this VIE have no recourse to the general credit of the
Company.
A third party organized a trust that is a SPE similar to the structure discussed
previously. The Company's relationship with the SPE is as a counterparty to a
credit default swap. This derivative transaction is accounted for in accordance
with SFAS 133 and is carried at fair value. The SPE has been determined to be a
VIE as defined by FIN 46. At September 30, 2003, the SPE had total assets of
$65.0 million and the Company's maximum exposure to loss was $3.8 million.
Hedge Funds
A consolidated subsidiary of the Company organized a hedge fund which seeks to
generate capital appreciation while minimizing risk and volatility for its
customers. This fund is a limited partnership and has been determined to be a
VIE as defined by FIN 46. The consolidated subsidiary of the Company is the
investment advisor and the general partner of the fund. At September 30, 2003,
the fund had total assets of $16.2 million. The Company's maximum exposure to
loss at September 30, 2003, which represents the Company's investment in the
fund was $.1 million.
An outside third party organized a hedge fund similar to the fund described
above. The Company is an equity investor in the fund. The fund has been
determined to be a VIE as defined by FIN 46. At September 30, 2003, the fund had
total assets of $440.0 million. As an equity investor, the Company's maximum
exposure to loss represents the Company's equity investment at September 30,
2003 of $94.8 million. The market risk on the notes has been passed to an
outside third party through a total return swap. The Company has concluded that
these funds do not require consolidation.
Trust Preferred Securities
At September 30, 2003, the Company consolidated several Capital Trust entities.
These entities issued preferred capital securities and common stock. The trust
invested the proceeds of these offerings, in junior subordinated debentures of
the Company. The capital trust collects payments on the junior subordinated debt
and in turn, makes payments on the capital securities. At September 30, 2003 and
December 31, 2002 the capital trusts had total assets of $1,114.4 million and
$1,092.2 million respectively. The Company consolidated a liability for the
capital securities and accrued interest on the securities of $1,081.0 million
and $1,059.4 million at September 30, 2003 and December 31, 2002 respectively.
The Company currently expects to de-consolidate $750 million of the capital
securities when FIN 46 is implemented during the fourth quarter of 2003. This
will result in the recognition of a liability to the trusts of approximately
$773 million plus related accrued interest and recognition of an investment in
the trusts of approximately $23 million as of December 31, 2003.
39.
Investments in Limited Partnerships
The Company participates as a limited partner in Low Income Housing Tax Credit
Partnerships. The Company's investments are typically less than 20% of the
limited partnerships' outstanding interests. The investment in these limited
partnerships, which also represents the Company's maximum exposure to loss was
$74.8 million and $75.1 million at September 30, 2003 and December 31, 2002
respectively. These entities have been determined to be VIEs as defined by FIN
46. The VIEs had total assets of $1,916.3 million at September 30, 2003. The
Company is not required to consolidate these VIEs since it will not incur a
majority of the expected losses.
Capital
- --------------------------------------------------------------------------------
Total common shareholder's equity was $7.2 billion at September 30, 2003 and
$6.9 billion at December 31, 2002. The Company has elected to temporarily delay
the declaration of additional common dividends pending the determination of cash
and/or capital requirements related to possible transactions with Household
currently under consideration.
The following table presents the capital ratios of the Company. To be
categorized as well-capitalized under the Federal Reserve Board guidelines, a
banking institution must have a minimum total risk-based capital ratio of at
least 10%, a Tier 1 risk-based ratio of at least 6%, and Tier 1 leverage ratio
of at least 5%.
- ------------------------------------------------------------------------------
September 30, December 31,
2003 2002
- ------------------------------------------------------------------------------
Total capital (to risk weighted assets) 13.59% 14.24%
Tier 1 capital (to risk weighted assets) 9.28 9.36
Tier 1 capital (to average assets) 6.27 5.98
- ------------------------------------------------------------------------------
Market Risk
- --------------------------------------------------------------------------------
In consideration of the degree of interest rate risk inherent in the banking
industry, the Company has interest rate risk management policies designed to
meet performance objectives within defined risk/safety parameters. In the course
of managing interest rate risk, a combination of risk assessment techniques,
including dynamic simulation modeling, gap analysis, Value at Risk (VAR) and
capital at risk analyses are employed. The combination of these tools enables
management to identify and assess the potential impact of interest rate
movements and take appropriate action.
Certain limits and benchmarks that serve as guidelines in determining the
appropriate levels of interest rate risk for the institution have been
established. One such limit is expressed in terms of the Present Value of a
Basis Point (PVBP), which reflects the change in absolute value of the balance
sheet for a one basis point upward movement in all interest rates. The
institutional PVBP limit as of September 30, 2003 was $4.0 million, which
includes distinct limits associated with trading portfolio activities and
financial instruments. Thus, for a one basis point upward change in interest
rates, the policy dictates that the absolute value of the balance sheet shall
40.
not change by more than $4.0 million. As of September 30, 2003, the Company had
an absolute value position of $1.0 million PVBP reflecting the impact of a one
basis point increase in interest rates.
The Company also monitors changes in value of the balance sheet for large
movements in interest rates with an overall limit of +/- 10%, after tax, change
from the base case valuation for either a 200 basis point gradual rate increase
or a 100 basis point gradual rate decrease. As of September 30, 2003, for a
gradual 200 basis point increase in rates, the value was projected to drop by 9%
and for a 100 basis point gradual decrease in rates, value was projected to drop
by 2%. The projected drop in value for a 100 basis point gradual decrease in
rates is primarily related to the anticipated acceleration of prepayments for
the held mortgage and mortgage backed securities portfolios in this lower rate
environment. This assumes that no management actions are taken to manage
exposures to the changing interest rate environment.
In addition to the above mentioned limits, the Company's Asset and Liability
Policy Committee particularly monitors the simulated impact of a number of
interest rate scenarios on net interest income. These scenarios include both
rate shock scenarios which assume immediate market rate movements of 200 basis
points, as well as rate change scenarios in which rates rise or fall by 200
basis points over a twelve month period. The individual limit for such gradual
200 basis point movements is currently +/- 10%, pretax, of base case earnings
over a twelve month period. Simulations are also performed for other relevant
interest rate scenarios including immediate rate movements and changes in the
shape of the yield curve or in competitive pricing policies. Net interest income
under the various scenarios is reviewed over a twelve month period, as well as
over a three year period. The simulations capture the effects of the timing of
the repricing of all assets and liabilities, including derivative instruments
such as interest rate swaps, futures and option contracts. Additionally, the
simulations incorporate any behavioral aspects such as prepayment sensitivity
under various scenarios.
For purposes of simulation modeling, base case earnings reflect the existing
balance sheet composition, with balances generally maintained at current levels
by the anticipated reinvestment of expected runoff. These balance sheet levels
will however, factor in specific known or likely changes, including material
increases, decreases or anticipated shifts in balances due to management
actions. Current rates and spreads are then applied to produce base case
earnings estimates on both a twelve month and three year time horizon. Rate
shocks are then modeled and compared to base earnings (earnings at risk), and
include behavioral assumptions as dictated by specific scenarios relating to
such factors as prepayment sensitivity and the tendency of balances to shift
among various products in different rate environments. This assumes that no
management actions are taken to manage exposures to the changing environment
being simulated.
41.
Utilizing these modeling techniques, a gradual 200 basis point parallel rise or
fall in the yield curve on October 1, 2003 would cause projected net interest
income for the next twelve months to decrease by $74 million (-2%) and to
increase by $40 million (+1%) respectively. These changes are well within the
Company's +/- 10% limit. An immediate 100 basis point parallel rise or fall in
the yield curve on October 1, 2003, would cause projected net interest income
for the next twelve months to decrease by $113 million and $84 million
respectively. An immediate 200 basis point parallel rise or fall would decrease
projected net interest income for the next twelve months by $230 million and
$233 million respectively. In addition, simulations are performed to analyze the
impact associated with various twists and shapes of the yield curve. If the
yield curve were to flatten significantly (i.e. long end of the yield curve
down) over the next twelve months, the projected margin could shrink by
approximately 5% to 8%, assuming no management actions.
The projections do not take into consideration possible complicating factors
such as the effect of changes in interest rates on the credit quality, size and
composition of the balance sheet. Therefore, although this provides a reasonable
estimate of interest rate sensitivity, actual results will vary from these
estimates, possibly by significant amounts.
Trading Activities
- --------------------------------------------------------------------------------
The trading portfolios of the Company have defined limits pertaining to items
such as permissible investments, risk exposures, loss review, balance sheet size
and product concentrations. "Loss review" refers to the maximum amount of loss
that may be incurred before senior management intervention is required.
The Company relies upon Value at Risk (VAR) analysis as a basis for quantifying
and managing risks associated with the trading portfolios. Such analysis is
based upon the following two general principles:
(i) VAR applies to all trading positions across all risk classes including
interest rate, equity, commodity, optionality and global/foreign exchange risks
and
(ii) VAR is based on the concept of independent valuations, with all
transactions being repriced by an independent risk management function using
separate models prior to being stressed against VAR parameters.
VAR attempts to capture the potential loss resulting from unfavorable market
developments within a given time horizon (typically ten days), given a certain
confidence level (99%) and based on a two year observation period.
VAR calculations are performed for all material trading and investment
portfolios and for market risk-related treasury activities. The VAR is
calculated using the historical simulation or the variance/covariance
(parametric) method.
42.
A VAR report broken down by trading business and on a consolidated basis is
distributed daily to management. To measure the accuracy of the VAR model
output, the daily VAR is compared to the actual result from trading activities.
The following table summarizes trading VAR of the Company.
- -----------------------------------------------------------------------------------------
3rd Quarter 2003
September 30, ------------------------------- December 31,
2003 Minimum Maximum Average 2002
- -----------------------------------------------------------------------------------------
in millions
Total trading $19.4 $13.3 $28.0 $20.7 $11.4
Commodities 6.3 .9 7.0 3.4 2.6
Credit derivatives 2.6 .6 3.6 1.9 2.1
Equities 2.3 .5 6.2 2.3 1.0
Foreign exchange 5.6 2.6 10.8 5.4 3.1
Interest rate 17.6 12.6 28.5 18.5 8.6
- -----------------------------------------------------------------------------------------
The following summary illustrates the Company's daily revenue earned from market
risk-related activities during the third quarter of 2003. Market risk-related
revenues include realized and unrealized gains (losses) related to treasury and
trading activities, but excludes the related net interest income. The analysis
of the frequency distribution of daily market risk-related revenues shows that
there were 16 days with negative revenue during the third quarter of 2003. The
most frequent result was a daily revenue of between zero and $2 million with 27
occurrences. The highest daily revenue was $5.9 million and the largest daily
loss was $3.3 million.
- --------------------------------------------------------------------------------------------------
Ranges of daily revenue
earned from market
risk-related activities
(in millions) Below $(2) $(2) to $0 $0 to $2 $2 to $4 Over $4
- --------------------------------------------------------------------------------------------------
Number of trading days
market risk-related
revenue was within the
stated range 3 13 27 15 6
- --------------------------------------------------------------------------------------------------
43.
Recently Issued Accounting Standards
- --------------------------------------------------------------------------------
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN 46). FIN 46 requires a VIE to be consolidated by
a company if that company is subject to a majority of the risk of loss from the
VIE's activities, or is entitled to receive a majority of the VIE's residual
returns, or both. FIN 46 increases required disclosures by a company
consolidating a VIE and also requires disclosures about VIEs that the company is
not required to consolidate, but in which it has a significant variable
interest.
The Company is currently reviewing the impact of the consolidation requirements
of FIN 46, which apply immediately to VIEs created after January 31, 2003. On
October 9, 2003, the FASB issued FASB Staff Position No. FIN 46-6, Effective
Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities
which delayed the consolidation requirements of FIN 46 to the fourth quarter of
2003 for VIEs established prior to January 31, 2003. The disclosure requirements
apply to all financial statements issued after January 31, 2003, regardless of
when the VIE was established.
Further information regarding the Company's interest in VIEs is provided under
Off-Balance Sheet Arrangements in this document.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
- --------------------------------------------------------------------------------
Refer to the disclosure in Item 2 of the Management's Discussion and Analysis of
Financial Condition and Results of Operations under the caption "Market Risk."
Item 4. Controls and Procedures
- --------------------------------------------------------------------------------
Under the direction of the Company's Chief Executive Officer (CEO) and Chief
Financial Officer (CFO), the Company has reviewed its "disclosure controls and
procedures". That term means controls and other procedures designed to ensure
that information required to be disclosed in the Company's reports filed with
the United States Securities and Exchange Commission (SEC) is recorded,
processed, summarized and reported by the due dates specified by the SEC's
rules. Such controls and procedures must be designed to ensure that information
required to be disclosed in reports filed with the SEC, is accumulated and
communicated to the Company's management personnel to allow timely decisions
regarding required disclosure. Also, this process is the support for the
certifications of the CEO and CFO included as exhibits to this report.
Since 1993, the CEO and CFO have reported on the Bank's internal controls over
financial reporting pursuant to FDICIA regulations. The Company's independent
auditors have annually attested, without qualification, to the reports. Thus
management is well acquainted with the process underlying the
44.
attestation to financial reporting controls. The current review process is built
on the annual review at the Bank for FDICIA purposes as well as various other
internal control processes and procedures, which management has established and
monitors. The review is conducted quarterly and includes all subsidiaries of the
Company.
To monitor the Company's compliance with the disclosure controls and procedures,
the Company has formed a Disclosure Committee chaired by its CFO. The Disclosure
Committee is composed of key members of senior management, who have knowledge of
significant portions of the Company's internal control system as well as the
business and competitive environment in which the Company operates. The
Disclosure Committee covers all of the Company's significant business and
administrative functions. One of the key responsibilities of each Committee
member is to review the document to be filed with the SEC as it progresses
through the preparation process. Open lines of communication to financial
reporting management exist for Disclosure Committee members to convey comments
and suggestions.
The Disclosure Committee has designated a preparation working group that is
responsible for providing and/or reviewing the detail supporting financial
disclosures. The Disclosure Committee also has designated a business issues
working group that is responsible for the development of forward-looking
disclosures.
The Company's CEO and CFO have concluded that, based on the deliberations of the
Disclosure Committee and input received from senior business and financial
managers, the Company's disclosure controls and procedures were effective as of
September 30, 2003 and that those controls and procedures support the
disclosures in this document. During the nine months ended September 30, 2003,
there were no material changes in the Company's internal controls over financial
reporting.
45.
Part II - OTHER INFORMATION
- --------------------------------------------------------------------------------
Item 1 - Legal Proceedings
The disclosures required hereunder are incorporated by reference to
Note 5 to the consolidated financial statements.
Item 5 - Other Information
On April 30, 2003, the Bank announced that it had entered into an
agreement with the Federal Reserve Bank of New York and the New York
State Banking Department to enhance its compliance with anti-money
laundering requirements. As set forth in the written agreement, the
Bank has agreed to a number of improvements to its compliance,
reporting, and review systems and procedures. The written agreement
was filed as an exhibit to the March 31, 2003 Form 10-Q of the
Company and is incorporated herein by reference. The foregoing
discussion of the regulatory agreement is qualified in its entirety
by reference to the text of the agreement.
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits -
3(i) Registrant's Restated Certificate of Incorporation and
Amendments thereto, Exhibit 3(a) to the Company's 1999 Annual
Report on Form 10-K incorporated herein by reference.
(ii) Registrant's By-Laws, as Amended to Date, Exhibit 3 to the
Company's Form 10-Q for the quarter ended June 30, 2002
incorporated herein by reference.
4 Instruments Defining the Rights of Security Holders, Including
Indentures, incorporated by reference to previously filed
periodic reports.
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.0 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
(b) Reports on Form 8-K
A current report on Form 8-K was filed August 4, 2003 furnishing the
information required by Item 12 of Form 8-K, "Results of Operation
and Financial Condition" by reference to HSBC USA Inc.'s press
release issued on that date.
46.
SIGNATURE
- --------------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
HSBC USA Inc.
(Registrant)
Date: November 14, 2003 /s/ Joseph R. Simpson
----------------------------------------
Joseph R. Simpson
Senior Vice President & Controller
(On behalf of Registrant and
as Chief Accounting Officer)